Strategic environmental policy when the governments are threatened by relocation

This paper analyzes how the threat of relocation influences environmental policy. The stringency of environmental policy is determined in a game between two governments. There is one firm in each jurisdiction, and both firms threaten to relocate their production to the other jurisdiction. Because there is asymmetric information about the cost of relocation, the governments do not know the credibility of the threat. We compare the outcome of this game with the outcome of a game in which relocation is not possible. We find that the threat of relocation can increase both the level of environmental regulation and welfare. The profit tax level proves to be the most decisive for the result; that is, the higher the profit tax level, the lower the level of environmental regulation.